the difference between short-term notes payable and bonds payable

A liability is created when a company signs a note for the purpose of borrowing money or extending its payment period credit. A note may be signed for an overdue invoice when the company needs to extend its payment, when the company borrows cash, or in exchange for an asset. An extension of the normal credit period for paying amounts owed often requires that a company sign a note, resulting in a transfer of the liability from accounts payable to notes payable. Notes payable almost always require interest payments. Short-term notes payable are notes that must be repaid with 12 months.


One source of financing available to corporations is long-term bonds. (Bonds are almost never short-term). Bonds represent an obligation to repay a principal amount at a future date and pay interest, usually on a semi-annual basis. Unlike notes payable, which normally represent an amount owed to one lender, a large number of bonds are normally issued at the same time to different lenders. These lenders, also known as investors, may sell their bonds to another investor prior to their maturity.

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Capital Lease Criteria

  Transfers ownership of the property
               --> to the lessee by the end of the lease term.

       Contains a bargain purchase option.

       Lease term is
               --> equal to 75 percent or more
                     of economic life of leased property.

       Present value of the minimum lease payments
              ( at the beginning of the lease term)
              --> equals or exceeds 90 percent of
                    the excess of the fair value of the leased property
               [SFAS 13, Para. 7]

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International Financial Reporting Standards

In the over 100 countries that govern accounting using International Financial Reporting Standards, the controlling standard is IAS 17, "Leases". While similar in many respects to FAS 13, IAS 17 avoids the "bright line" tests (specifying an exact percentage as a limit) on the lease term and present value of the rents. Instead, IAS 17 has the following five tests. If any of these tests are met, the lease is considered a finance lease:

• ownership of the asset is transferred to the lessee at the end of the lease term;
• the lease contains a bargain purchase option to buy the equipment at less than fair market value;
• the lease term is for the major part of the economic life of the asset even if title is not transferred;
• at the inception of the lease the present value of the minimum lease payments amounts to at least substantially all of the fair value of the leased asset.
• the leased assets are of a specialised nature such that only the lessee can use them without major modifications being made.

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Finance lease

A finance lease or capital lease is a type of lease. It is a commercial arrangement where:

• the lessee (customer or borrower) will select an asset (equipment, vehicle, software);
• the lessor (finance company) will purchase that asset;
• the lessee will have use of that asset during the lease;
• the lessee will pay a series of rentals or installments for the use of that asset;
• the lessor will recover a large part or all of the cost of the asset plus earn interest from the rentals paid by the lessee;
• the lessee has the option to acquire ownership of the asset (e.g. paying the last rental, or bargain option purchase price);

The finance company is the legal owner of the asset during duration of the lease.
However the lessee has control over the asset providing them the benefits and risks of (economic) ownership.


A finance lease differs from an operating lease in that:

• in a finance lease the lessee has use of the asset over most of its economic life and beyond (generally by making small 'peppercorn' payments at the end of the lease term).

In an operating lease the lessee only uses the asset for some of the asset's life.

• in a finance lease the lessor will recover all or most of the cost of the equipment from the rentals paid by the lessee.

In an operating lease the lessor will have a substantial investment or residual value on completion of the lease.

• in a finance lease the lessee has the benefits and risks of economic ownership of the asset (e.g. risk of obsolescence, paying for maintenance, claiming capital allowances/depreciation).

In an operating lease the lessor has the benefits and risks of owning the asset.
The U.S. Financial Accounting Standards Board and the International Accounting Standards Board announced in 2006 a joint project to comprehensively review lease accounting standards. The boards' stated intention is to recognize an asset and obligation for all leases (in essence, making all leases finance leases). The projected completion of the project is now mid-2011

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Capital Lease vs Operating Lease

Firms often choose to lease long-term assets rather than buy them for a variety of reasons - the tax benefits are greater to the lessor than the lessees, leases offer more flexibility in terms of adjusting to changes in technology and capacity needs. Lease payments create the same kind of obligation that interest payments on debt create, and have to be viewed in a similar light. If a firm is allowed to lease a significant portion of its assets and keep it off its financial statements, a perusal of the statements will give a very misleading view of the company's financial strength. Consequently, accounting rules have been devised to force firms to reveal the extent of their lease obligations on their books.
There are two ways of accounting for leases. In an operating lease, the lessor (or owner) transfers only the right to use the property to the lessee. At the end of the lease period, the lessee returns the property to the lessor. Since the lessee does not assume the risk of ownership, the lease expense is treated as an operating expense in the income statement and the lease does not affect the balance sheet. In a capital lease, the lessee assumes some of the risks of ownership and enjoys some of the benefits. Consequently, the lease, when signed, is recognized both as an asset and as a liability (for the lease payments) on the balance sheet. The firm gets to claim depreciation each year on the asset and also deducts the interest expense component of the lease payment each year.  In general, capital leases recognize expenses sooner than equivalent operating leases. 
Since firms prefer to keep leases off the books, and sometimes prefer to defer expenses, there is a strong incentive on the part of firms to report all leases as operating leases. Consequently the Financial Accounting Standards Board has ruled that a lease should be treated as an capital lease if it meets any one of the following four conditions -
     (a) if the lease life exceeds 75% of the life of the asset
     (b) if there is a transfer of ownership to the lessee at the end of the lease term
     (c) if there is an option to purchase the asset at a "bargain price" at the end of the lease term.
     (d) if the present value of the lease payments, discounted at an appropriate discount rate, exceeds 90% of the fair market
         value of the asset.
The lessor uses the same criteria for determining whether the lease is a capital or operating lease and accounts for it accordingly. If it is a capital lease, the lessor records the present value of future cash flows as revenue and recognizes expenses. The lease receivable is also shown as an asset on the balance sheet, and the interest revenue is recognized over the term of the lease, as paid.
From a tax standpoint, the lessor can claim the tax benefits of the leased asset only if it is an operating lease, though the revenue code uses slightly different criteria for determining whether the lease is an operating lease.
When a lease is classified as an operating lease, the lease expenses are treated as operating expense and the operating lease does not show up as part of the capital of the firm. When a lease is classified as a capital lease, the present value of the lease expenses is treated as debt, and interest is imputed on this amount and shown as part of the income statement. In practical terms, however, reclassifying operating leases as capital leases can increase the debt shown on the balance sheet substantially especially for firms in sectors which have significant operating leases; airlines and retailing come to mind.
We would make the argument that in an operating lease, the lease payments are just as much a commitment as lease expenses in a capital lease or interest payments on debt. The fact that the lessee may not take ownership of the asset at the end of the lease period, which seems to be the crux on which the operating/capital lease choice is made, should not be a significant factor in whether the commitments are treated as the equivalent of debt.
Converting operating lease expenses into a debt equivalent is straightforward. The operating lease payments in future years, which are revealed in the footnotes to the financial statements for US firms, should be discounted back at a rate that should reflect their status as unsecured and fairly risky debt. As an approximation, using the firm’s current pre-tax cost of debt as the discount rate yields a good estimate of the value of operating leases. Note that capital leases are accounted for similarly in financial statements, but the significant difference is that the present value of capital lease payments is computed using the cost of debt at the time of the capital lease commitment, and is not adjusted as market rates change

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Long term liabilities

Long term liabilities are those that are due to be paid in more than an year. Those due in less than a year or on demand are current liabilities.
The most important type of long term liability is debt. Preference shares are not debt, but given that they are "debt like" this is often something investors should adjust for.
Similarly, some short term debt can keep being renewed, so it in fact provides long term funding. This sometimes happens with overdrafts: they are repayable on demand and therefore short term debt, but a company may maintain an overdraft for many years.
Conversely debt instruments that originally had a long term that are now close to expiry are short term debt, and shown as such in the accounts.
Long term liabilities are looked at by investors assessing a company's financial health using ratios such as interest cover. Because of gearing high debt enhances the benefits of growth.
Like shareholders, the holders of long term debt (i.e. banks and bondholders) are suppliers of funds to a company. They rank higher than shareholders in getting their money back if a company fails and therefore their money is safer, but they do not gain if the company performs better than the minimum necessary to pay back its debt.

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Common Stock

As already mentioned in discussing the stock market, a stock is a share in the ownership of a company. Stock represents a claim on the company's assets and earnings. The more stock you are holding, the greater is your ownership stake in the company. Being a shareholder, however does not mean you have any input in the day-to-day running of the business. Instead, the degree of influence of a person holding the stock is restricted to one vote per share to elect the board of directors at annual meetings. Although meaning of the stock is quite easy to grasp, all the variations of the stock can make investing in the stock market somewhat confusing.
Common stock is the most typical type of stock. When people discuss investing in stocks in general they are most likely referring to this type of stock. In fact, the greatest number of stock issued is in this form. Common shares represent ownership in a company and a claim (dividends) on a portion of profits. Investing persons or firms get one vote per stock share to elect the board members, who oversee the major decisions made by management.
Study of investing and stock market has revealed that in the long term, common stock, by means of capital growth, yields higher returns than almost every other investment. This higher return comes at a cost, because common stock carries the greatest risk. In case the company goes bankrupt and liquidates, the investor holding common stock shares will not receive money until the creditors, bondholders, and preferred shareholders are paid.

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Treasury Stock

When analyzing a balance sheet, you're apt to run across an entry under Shareholder Equity called "Treasury Stock". This refers to the shares a company has issued and somehow reacquired either through share repurchase programs or donations.
Companies sometimes buy back their shares for a variety of reasons. In most cases, it is a sign management believes the stock is undervalued. Depending upon its objectives, a company can either retire the shares it purchases, or hold them with the intention of reselling them to raise cash when the stock price rises.
When a corporation purchases its own stock, the cash on hand is reduced. This lowers the total shareholder equity. In order for investors to know the reduced cash and equity was a result of share repurchases and not debt or losses, management puts the cost of the reacquired stock under "Treasury Stock" in order to clarify. This is why you will often see a negative number besides the treasury stock entry. (You may be wondering why the current market price of the company's treasury stock isn't listed as an asset since the shares can be sold at any time to raise cash. There is a debate about this in the accounting world. The premise is that all unissued stock can also be sold for cash yet it isn't listed as an assets - treasury stock should be treated the same way.)
Many states limit the amount of treasury stock a corporation can own at any given time since it is way of taking resources out of the business by the owners / shareholders, which in turn, may jeopardize the legal rights of the creditors.

Treasury Stock Not Permitted In Some States

Some states don't allow companies to carry treasury stock on the balance sheet, instead requiring them to retire shares

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Paid in capital

Paid in  capital (also called contributed capital) is a balance sheet item, showing what has been invested by stockholders through purchase of stock from the corporation (not through purchase of stock on the open market from other stockholders). When investors buy shares directly from the company, that is, the company receives and keeps the funds as contributed capital (paid in capital). When shares are bought on the open market, of course, funds go to the investor selling them. 

Contributed (paid in capital) capital is one of the two main categories on the balance sheet under owner’s equity (the other is retained earnings). Contributed capital, in turn, has two main components:

• Stated capital, which is usually defined as the stated, or par value of the shares of stock that have been isssued ( the stated capital is listed on the balance sheet below is the cum of values listed for as "Preferred stock" and "Common stock.").

• Additional paid-in capital, which represents money paid to the company above the par value. 

Contributed capital (paid in capital) entries on the balance sheet show up under Owner's Equity, as shown in the lower part of this example:

Grande Corporation    Balance Sheet at 31 December 2011   Assets    Current Assets ............................... 9,609    Long Term Investments & Funds ................ 1,460    Property, Plant & Equipment .................. 9,716    Intangible Assets............................. 1,222    Other Assets..................................    68      Total Assets....................................... 22,075   Liabilities    Current Liabilities..........................  3,464    Long Term Liabilities........................  5,474      Total Liabilities .................................  8,938   Owners Equity    Contributed Capital      Preferred stock...................... 3,798      Common stock......................... 4,184      Contributed capital in excess of par. 1,457        Total contributed capital...............   9,439    Retained Earnings ..........................   3,698      Total Stockholder's Equity......................... 13,137       Total Libabities and Equities..................... 22,075

Stated capital is the sum of the stock par values listed, "Preferred stock" and "Common stock."

Contributed Capital and Stock Offerings

At a public stock offering, the difference between a stock's par value and the actual market price can be large. Par value for a stock is an accounting convention for the price intiially set by the company. The concept came into use as a way of letting companies announce publicy that thay will sell no shares below a certain price (par), so as to assure investors that no one will receive more favorable prices.
At a company's IPO (Initial public offering), however, the market price can rise far above par, especially if the investing public has high expectations for company growth and company performance.The same difference may appear at the company's secondary, and subsequent stock offerings to the public. In brief, par value says little about the market's confidence in the company or potential future stock prices. What investors are willing to pay, in excess of par, however, is viewed as an indicator of fufture performance. For this indicator, they can look to the separate components of contributed capital on the balance sheet.

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Retained Earnings on the Balance Sheet

When a company generates a profit, management has one of two choices: They can either pay it out to shareholders as a cash dividend, or retain the earnings and reinvest them in the business. 

When the executives decide that earnings should be retained, they have to account for them on the balance sheet under shareholder equity. This allows investors to see how much money has been put into the business over the years. Once you learn to read the income statement, you can use the retained earnings figure to make a decision on how wisely management is deploying and investing the shareholders' money. If you notice a company is plowing all of its earnings back into itself and isn't experiencing exceptionally high growth, you can be sure that the stock holders would be better served if the board of directors declared a dividend.
Ultimately, the goal for any successful management is to create $1 in market value for every $1 of retained earnings.

Retained Earnings Examples from Real Companies

Let's look at an example of retained earnings on the balance sheet:

• Microsoft has retained $18.9 billion in earning over the years. It has over 2.5 times that amount in stockholder equity ($47.29 billion), no debt, and earned over 12.57% on its equity last year. Obviously, the company is using the shareholder's money very effectively. With a market cap of $314 billion, the software giant has done an amazing job.
• Lear Corporation is a company that creates automotive interiors and electrical components for everyone from General Motors to BWM. As of 2001, the company had retained over $1 billion in earnings and had a negative tangible asset value of $1.67 billion dollars! It had a return on equity of 2.16%, which is less than a passbook savings account. The company is astronomically priced at 79.01 times earnings and has a market cap of $2.67 billion. In other words: Shareholders have reinvested a billion dollars of their money back into the company and what have they gotten? They owe $1.67 billion.¹ That is a bad investment. 
• The Lear example deserves a closer look. It is immediately apparent that shareholders would have been better off had the company paid out its earnings as dividends. Unfortunately, the economics of the company are so bad had the profits been paid out, the business probably would have gone bankrupt. The earnings are reinvested at a sub par rate of return. An investor would earn more on the earnings by putting them in a CD or money market fund then by reinvesting them into the business. 

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Accounting And Reporting Corporations

Companies and close corporations (CCs) must keep the following: records showing assets and liabilities; a register of fixed assets; records containing daily entries of all cash received and disbursed; records of all credit purchases or sales and services received or rendered on credit, in sufficient detail to identify the nature of the transactions and the parties concerned; statements of annual stock taking; records enabling the value of stock at the end of the year to be determined and vouchers supporting entries in the accounting records.
A corporation must also keep records of members' contributions, un-drawn profits and revaluations of fixed assets and amounts of loans to and from members, in sufficient detail to identify the nature and purpose of the individual transactions clearly.
These records must be kept in such a manner as to provide adequate precautions against falsification and to facilitate the discovery of any such falsification. A corporation that fails to keep such accounting records and every member who fails to take all reasonable steps to prevent falsification is guilty of an offence. However, if the members entrusted the duty of keeping the accounting records or maintaining a system of internal control to a 'competent and reliable person', this would be sufficient defence.
The financial year of a CC is its annual accounting period. A CC must specify the date of the end of its financial year in its founding statement. As is the case with other information in the founding statement, the date of the end of the financial year may be changed by, registering an amended founding statement.
The members of a corporation must, within a maximum of nine months after the end of every financial year, have financial statements prepared. The financial statements must be approved and signed by or on behalf of every member of the corporation and must consist of an accounting balance sheet and notes thereto and an income statement or any similar financial statement, where such form is appropriate and any notes thereto.
The financial statements must disclose separately the aggregate amounts at the end of the accounting financial year and any changes in these amounts during the year of contributions by members, un-drawn profits, revaluations of fixed assets, amounts of loans to members and amounts of loans from members.
The Close Corporation Act does not require a directors' report or an auditors' report and also does not contain a schedule, which lays down specific requirements for the preparation of annual financial accounting statements. The financial reports of a CC must, in conformity with Generally Accepted Accounting Practice (GAAP) appropriate to the business of the corporation, fairly present the state of affairs of the corporation at the end of the financial year concerned and the result of its operations for the year.
In determining what constitutes generally acceptable accounting policy for the business of a particular corporation, the needs of the members and the primary users of the financial statements should be taken into account.
Over the years accounting practices in the various economic and industrial environments have developed in such a manner as to record and fairly present transactions and occurrences specific to these environments. In deciding what is 'suitable for the business', consideration should also be given to the commercial and management activities of the corporation and the accepted accounting practice in the working environment of the corporation.

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Accounting For Partnership

Most of the on-going accounting for partnerships is the same as for any other form of business organization. The chart of accounts differs only for the equity accounts where we find a drawing account and a capital account for each partner. There are, however, some areas which are peculiar to partnerships. The formation of a partnership, the distribution of income, the admission of new partners and the dissolution and liquidation of a partnership all require special accounting treatment.
When a partnership is formed, a separate entry is made for each partner's investment. Assets contributed by a partner are debited to the appropriate accounts. If the partnership assumes any liabilities, the proper accounts are credited. The partner's capital account is then credited for the difference. A partner may contribute not only cash and property, but a variety of assets. When two businesses are merged into a partnership, each incoming partner may also contribute inventory and accounts receivable. The partnership may assume the accounts payable as well as other liabilities of the prior businesses. Equipment is valued at current market value, and, therefore, these amounts may differ from the book value of the separate businesses. Receivables are recorded at their face amount. A provision may be made for any potentially uncollectible amounts by crediting an Allowance for Doubtful Accounts.
Partnership agreements provide for the distribution of income in a variety of ways. Income may be divided in proportion to ownership, to time spent in the business, or in any manner decided by the partners. Of course, they must consider any IRS rullings regarding related parties or potential tax avoidance. One or more partners may be guaranteed a fixed amount in the form of a salary or as interest payments. The partners may take regular cash withdrawals. All of these situations must be properly handled so that each partner's equity is correctly maintained.
The standard procedure is to set up a drawing account for each partner This account is debited for any withdrawals during the year. At year end, the division of net income is recorded as a closing entry with the proper amount of income or loss applied to each partner's capital account. The drawing account is also closed to the partner's capital account. In this manner, each partner's capital account will reflect his net activity for the year. If the partner has withdrawn more than his share of income, this will be reflected by a decrease in his capital account.
The admission of one or more new partners is another area peculiar to partnerships. A new partner may be admitted in one of two ways. He may purchase an interest from one or more of the existing partners or he may contribute new assets to the partnership. When an interest is purchased, neither the total assets nor the total equity of the partnership is changed. The transaction merely causes changes in the equity accounts. Assume that a partnership has a total equity of $300,000. If Partner A sells one-third of his interest to a new Partner Z and Partner A has a balance in his capital account of $90,000, Partner Z would be entered on the books with a capital account balance of $30,000 and Partner A would then have a capital account balance of $60,000. If new Partner Z felt that the assets of the partnership were worth more than their book value or that the partnership itself was earning at a high rate, he might have paid Partner A more than the $30,000 for his interest. This fact does not affect the partnership entries in any way. The total partnership equity remains at $300,000. Any increase in asset value is handled by the new partners outside the partnership.
Instead of buying an interest from the existing partners, a new partner may contribute assets to the partnership. In this case both total assets and total equity of the business are changed. If new Partner Y contributes cash and equipment worth $50,000 to the partnership, the entries are similar to the entries when the partnership was formed. The proper asset accounts are debited and a capital account is set up for Partner Y in the amount of $50,000. If the market value of the partnership's assets is not a good reflection of the book value of the partnership assets, the partnership assets may be adjusted accordingly. The assets are revalued and the net amount of any increase or decrease is allocated to the partner's capital accounts in accordance with their income sharing ratio.
When a partner withdraws from a partnership, the accounting treatment is in effect just the reverse of the treatment for an entering partner. The remaining partners may purchase the withdrawing partner's interest. Again in this case, as above, the settlement for the purchase is done by the partners as individuals. The partnership need only debit the capital account of the withdrawing partner and credit the capital account of the partners having purchased his interest.
If the partner merely withdraws and removes any assets equal to the balance of his capital account, then again we have the case where both total assets and total equity are changed. The remaining assets should be adjusted to reflect current market prices and the net adjustment is divided among the remaining partners in accordance with their income sharing ratio.
When a partnership goes out of business, it generally sells the assets, pays off any creditors and then distributes the remaining cash and any other assets
to the partners. The first accounting step in this liquidation is to close all income and expense accounts in the usual year-end manner. Only asset, liability and equity accounts remain open. If the remaining assets are sold at a gain, the gain is divided among the partners based on their income sharing ratio. Liabilities are paid and any remaining cash is distributed to the partners according to the balances in their capital accounts.
If the remaining assets are sold at a loss, the procedure is the same assuming the partner's capital balances are sufficient to absorb the loss. The loss is divided among the partners based on their income sharing ratio and any remaining cash after creditors are paid is distributed in accordance with the balances in the capital accounts. However, in the case where a partner's capital account is not large enough to absorb the loss, a deficiency is created. This is a claim on the partner by the partnership. If the deficiency is not made up by the partner, then this deficiency in turn reduces the capital accounts of the remaining partners. Any remaining cash is then distributed to partners in accordance with their final capital balances.

When a partneship is dissolved, the distribution of cash must be handled correctly. Distribution of cash must not be confused with the allocation of gains or losses on disposal of assets. Gains or losses on sale of assets to outsiders are allocated to the partners in their income sharing ratio. The final distribution of cash is based on their final capital balances.
As stated previously, it is true that accounting for partnerships is not complex and is very much like the accounting for any business enterprise. However, it is very important to handle the equity accounts correctly in order that they may properly reflect each partner's balance.

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Accounts Receivable Management

In managing accounts receivable, the following procedures are recommended:
Step-1. Establish a Credit policy

• A detailed review of a potential customer’s soundness should be made prior to extending credit. Procedures such as a careful review of the customer’s financial statements and credit rating, as well as a review of financial service reports.
• As customer financial health changes, credit limits should be revised.
• Marketing factors must be noted since an excessively restricted credit policy will lead to lost sales.
• If seasonal datings are used, the firm may offer more liberal payments than usual during slow periods in order to stimulate business by selling to customers who are unable to pay until later in the season. This policy is financially appropriate when the return on the additional sales plus the lowering in inventory costs is greater than the incremental cost associated with the additional investment in accounts receivable.

Step-2. Establish Billing Policy

• Customer statements should be sent within 1 day subsequent to the close of the period.
• Large sales should be billed immediately.
• Customers should be invoiced for goods when the order is processed rather than when it is shipped.
• Billing for services should be done on an interim basis or immediately prior to the actual services. The billing process will be more uniform if cycle billing is employed.
• The use of seasonal datings should be considered. (See item 4, concerning credit policy.)

Step-3. Collection Policy

• Accounts receivable should be aged in order to identify delinquent and high-risk customers. The aging should be compared to industry norms.
• Collection efforts should be undertaken at the very first sign of customer financial unsoundness.

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Accounts Receivable Financing

Accounts receivable financing has several advantages, including avoiding the need for long-term financing and obtaining a recurring cash flow base. Accounts receivable financing has the drawback of high administrative costs when there are many small accounts. However, with the use of computers these costs can be curtailed. Accounts receivable may be financed under either a “factoring“ or “assignment arrangement“. Factoring refers to the outright sale of accounts receivable to a bank or finance company without recourse. The purchaser takes all credit and collection risks. The proceeds received by the selling company are equal to the face value of the receivables less the commission charge, which is typically 2 to 4 percent higher than the prime interest rate. The cost of the factoring arrangement is the factor’s commission for credit investigation, interest on the unpaid balance of advanced funds, and a discount from the face value of the receivables where high credit risks exist. Remissions by customers are made directly to the factor.
The advantages of factoring include:

• Immediate availability of cash
• Reduction in overhead since the credit examination function is no longer required
• Utilization of financial advice
• Receipt of advances as needed on a seasonal basis
• Strengthening of the balance sheet position

The drawbacks to factoring include both the high cost and the poor impression left with customers because of the change in ownership of the receivables. Also, factors may antagonize customers by their demanding methods of collecting delinquent accounts. In an assignment, there is no transfer of the ownership of the accounts receivable.
Receivables are given to a finance company with recourse. The finance company typically advances between 50 and 85 percent of the face value of the receivables in cash. The borrower is responsible for a service charge, interest on the advance, and any resulting bad debt losses. Customer remissions continue to be made directly to the company.
The assignment of accounts receivable has a number of advantages, including the immediate availability of cash, cash advances available on a seasonal basis, and avoidance of negative customer feelings. The disadvantages include the high cost, the continuance of the clerical function associated with accounts receivable, and the bearing of all credit risks.
The financial manager should be aware of the impact of a change in accounts receivable policy on the cost of financing receivables.

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Basic Accounts Receivable Management

This article will outline some of the basic components for managing accounts receivable, ranging from policies and measurement to outsourcing options.

The foundation behind account receivables is your policies and procedures for sales. For example, do you have a credit policy? When and how do you evaluate a customer for credit? If you look at past payment histories, you should be able to ascertain who should get credit and who shouldn't. Additionally, you need to establish sales terms. For example, is it beneficial to offer discounts to speed-up cash collections? What is the industry standard for sales terms? There are several questions that have to be answered in building the foundation for managing accounts receivables.

A system must be in place to track accounts receivables. This will include balance forwards, listing of all open invoices, and generation of monthly statements to customers. An aging of receivables will be used to collect overdue accounts. You must act quickly to collect overdue accounts. Start by making phone calls followed by letters to upper-level managers for the Customer. Try to negotiate settlement payments, such as installments or asset donations. If your collection efforts fail, you may want to use a collection agency.

Also remember that the collection process is the art of knowing the customer. A psychological understanding of the customer gives you insights into what buttons to push in collecting the account. One of the biggest mistakes made in the collection process is a "sticks only" approach. For some customers, using a carrot can work wonders in collecting the overdue account. For example, in one case the company mailed a set of football tickets to a customer with a friendly note and within weeks, they received full payment of the outstanding account.

Measurement is another component within account receivable management. Traditional ratios, such as turnover will measure how many times you were able to convert receivables over into cash.

Example: Monthly sales were $ 50,000, the beginning monthly balance for receivables was $ 70,000 and the ending monthly balance was $ 90,000. The turnover ratio is:
.625 ($ 50,000 / (($70,000 + $ 90,000)/2)). Annual turnover is .625 x 360 / 30 or 7.5 times. If you divide 360 (bankers year) by 7.5, you get 48 days on average to collect your account receivables. You can also measure your investment in receivables. This calculation is based on the number of days it takes you to collect receivables and the amount of credit sales.

Example: Annual credit sales are $ 100,000. Your invoice terms are net 30 days. On average, most accounts are 13 days past due. Your investment in accounts receivable is:
(30 + 13) / 365 x $ 100,000 or $ 11,781.

Example: Average monthly sales are $ 10,000. On average, accounts receivable are paid 60 days after the sales date. The product costs are 50% of sales and inventory-carrying costs are 10% of sales. Your investment in accounts receivable is:
2 months x $ 10,000 = $ 20,000 of sales x .60 = $ 18,000.

Measurements may need to be modified to account for wide fluctuations within the sales cycle. The use of weights can help ensure comparable measurements.

Example: Weighted Average Days to Pay = Sum of ((Date Paid - Due Date) x Amount Paid) / Total Payments

Example: Best Possible Days Outstanding = (Current A/R x # of Days in Period) / Credit Sales for Period

Receivable Management also involves the use of specialist. After-all, you need to spend most of your time trying to lower your losses and not trying to collect overdue accounts. A wide range of specialist can help:

- Credit Bureau services to review and approve new customers.
- Deduction and collection agencies
- Complete management of billings and collections

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Analyzing Inventory

To analyze inventory activity and the resulting accounting transactions, you can use the following two types of reports produced by the NCAS:

• Daily reports which detail the inventory activity of the previous day, including
• receipts and receipt reversals
• transfers to and from warehouses
• issues and returns
• cost and quantity adjustments
• account changes

• Summary reports which summarize inventory activity for the previous period

Each report listed has a brief description of the report, including its contents, use and suggested frequency. This description also includes information on how to access the report: the reporting tool (RMDS or IE), the report group or report series, and the report ID. A sample of each report will be added to the topic at a later date.

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Payroll Accounting

Perhaps one of the most important accounting functions, at least from the perspective of the average worker, is payroll accounting.The wages an organization pays its employees is the actual amount of money a worker receives from an employer.Real wages represent the amount of goods and services workers can buy with their money wages.
Benefit packages, on the other hand, can represent a major portion of an overall compensation package provided by an organization, and an important function of a manager is to help design a benefits package which will make the organization attractive to potential and current employees, while balancing the economic realities of the costs associated with each component of the package.According to one expert, "Many employers provide insurance coverage, paid vacations, and a number of other such fringe benefits" including Employee Stock Ownership Plans which allow workers to own part or all of a company’s stock.These types of benefit programs are designed to encourage productive work and reward length of service.
Many companies also provide some type of pension program for their employees. In most programs, the benefits depend on an employee’s age, years of service, and average salary. Federal law requires that all pension plans offer vested pension rights to workers who have completed a certain number of years of service. Most employees become fully vested after five years or less of service. Employees with vested rights are guaranteed pension benefits after retirement even if they leave the firm before they retire. However, almost no pension plans provide cost-of-living increases.
There are four main kinds of private pension programs with which the payroll accountant must be familiar. These programs include:

1. trust-fund plans,
2. group annuity plans,
3. profit-sharing plans, and
4. thrift, or savings, plans.

Trust-fund plans pay benefits from a trust managed by a bank or other financial institution.Money paid to the pension funds is invested in stocks, bonds, and other sources of income.Most of the money is paid by the employer. Many employers who participate in trust-fund plans must pay premiums to a federal agency called the Pension Benefit Guaranty Corporation to insure worker benefits against inadequate funding.Group annuity plans cover all participants with an insurance policy financed either by the employer alone or by both the employer and the employees.The policy guarantees that each worker will receive a monthly annuity (payment) after retiring. Life insurance firms manage most group annuity plans.
Profit-sharing plans are funded by employers, largely from a portion of their annual profits. People may be paid in monthly installments or with one lump sum. Thrift, or savings, plans allow employees to make contributions for retirement.In most thrift plans, the employer matches a certain percentage of each employee’s contributions. Companies typically match 50 percent of an employee’s contributions up to a certain maximum amount.In most cases, an employee may contribute amounts above the maximum matched amount.One common type of company thrift plan is a 401 (k) plan. According to one benefits expert, "Under this plan, all or part of the contributions come from pretax income, and taxes are deferred until money is withdrawn.Withdrawals or loans from such an account are permitted up to a set limit and only under certain conditions.If the employee exceeds the limit or does not meet the conditions, a federal penalty tax must be paid.
Many employers provide a thrift plan in addition to another type of pension plan" (Haveman, 1999, p. 19). A on-going cost-benefit analysis of effectiveness of the pay structures and benefit packages provided by an organization is required to ensure that it is receiving the "most bang for the buck."

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Business Accounting

As shown by the valuable results of researches on the existing records of accounts, business accounting has traveled a long and winding path to the present double entry bookkeeping system through much trial-and-error for hundreds of years since the beginning of the thirteenth century (Izutani, 1980). Initially, business accounting was formulated as an income determination system for individual companies. With the establishment of the modern corporation system, particularly in the first half of the 19th century, business accounting, which had been working as the income determination system for individual companies, assumed a new role as a social control system, i.e., the distributable income determination system to "protect creditors" (Littleton, 1933, pp. 242).
Today, individual departments within an organization frequently require financial information that is tailored for their operations. According to David (2002), one size does not fit all when it comes to financial information. Financial information systems should provide a system wherein the details roll up to summarize the information and the information used for decision making is consistent with and reconciled with the organization’s financial records.
David (2002) lists the elements of the hierarchy of financial needs as follows:

• Budget Information – this element is the foundation of the hierarchy. It provides data on the amount of money available for expenditure on a program, project, or service.In addition, it provides revenue projections for which money is expected to be available for expenditures.
• Status of Funds – this element is the second element of the hierarchy. It provides financial information as to where an organization or department stands in relation to expenditures/obligations and the budget’s remaining balance.In addition, it provides information on revenue receipts in comparison to the projected budgeted revenue.
• Cost Management – provides information on resource use by program, project or service, irrespective of the source of funds. According to David (2002), most financial systems do not provide a cost management system.Therefore, the need exists to have cost management as part of the financial system in order to provide resource use for individual programs, projects, and services.
• Cost/Performance – this element is considered to be the top of the hierarchy. It intersects the cost of services, programs, and projects with their respective performance levels. Thus, it notes the relationship of service, program, or project results with the cost for attaining these results.

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Forensic Accountant

Black’s Law Dictionary tells us that "forensic" means, "Belonging to courts of justice" (1990, p. 648).A recent term coming into wider use is forensic accounting, which has been described as the application of financial expertise to legal disputes and investigations (Bologna, Lindquist & Bologna, 1995).Consequently, forensic accounting is accounting that involves litigation. "In such circumstances, accountants may be called on to provide expert investigations and evidence" (Hussey, 1999, p. 170).According to Marc A. Siegel (2001), the first step in conducting a forensic investigation is to gather as many details as possible about the facts of an alleged misappropriation; however, CPAs must be systematic to guard against "information overload," which can lead to important factors being overlooked.
Siegel offers the following tips for CPAs and others involved in forensic accounting activities:

• CPAs, investigators and attorneys need to develop a work plan and pool what they learn about the core facts every day.
• Forensic consultants should expect their work to be scrutinized in litigation since it is impossible to know whether a case will be tried or settled out of court. The lead attorney may consider at the beginning who on the financial team would make the most suitable expert witness.
• Understanding business customs before commencing a forensic investigation in another country will help an investigating CPA. Knowing the language is an important asset.
• A simple but effective way to track the developing understanding of the normal movements of cash in an organization is to use a flowchart. Once CPAs know how cash was supposed to move between all the parties, they can more readily see how the process was circumvented.
• The final report should clearly show that the CPA consultants in the investigation exercised objectivity. It should describe both sides of any issue, and document that the conclusions reached were based on data to which both sides in the dispute had equal access (Siegel, 2001, p. 45).

According to William M. Michaelson (1996), the process of locating hidden assets is one of components of forensic accounting, which he describes as being a fairly new discipline for CPA firms. Because forensic accounting involves applying financial facts to legal situations, it is becoming an important litigation service that practitioners offer to attorneys. However, in order to be effective, a forensic accountant must command a thorough understanding of the legal process, its unique language and the rules of evidence used in both federal and state courts (Michaelson, 1996).
Accountants are uniquely qualified to assist lawyers with searches for hidden assets in divorce cases in particular because of their knowledge and experience in financial document analysis, accounting principles and auditing techniques and our awareness of common schemes to secrete property. In order to be effective, searchers for hidden assets must analyze numerous financial documents and specific transactions, reviewing public and private records and discovering relationships and patterns among the data that indicate the existence of additional assets.Some of the sources of public records that will help reveal the business and personal background of someone suspected of hiding assets include the following:

• Clerk of the courts, for all lawsuits and judgments involving the spouse.
• Department of Motor Vehicles for automobile and boat registration.
• Federal Aviation Administration for airplane registration and pilot records.
• Tax assessor for property registered in the spouse's name.
• Departments of state for business entities in which the spouse is involved and associates connected to those businesses.
• Voter registration records.
• Uniform Commercial Code filings with the state.
• Securities and Exchange Commission for public filings and entities in which the spouse is involved.
• Professional licensing authorities (Michaelson, 1996).

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Bankruptcy Accounting

As the term implies, bankruptcy accounting deals with the laws surrounding the various chapters of the Bankruptcy Code.There is a growing need for this type of service.During the 1980s approximately 20,000 businesses a year filed for Chapter 11 protection, while individual bankruptcy filings exceeded 700,000 by the end of the decade (Quintero, 1991).
More significant still has been the recent trend of filings, with the majority of the 25 largest bankruptcies in U.S. history have been filed in the last 10 years.A number of companies languish in bankruptcy and appear to be unable to make any apparent progress toward rehabilitation. For instance, a report issued at the end of 1989 by the Administrative Office of the Courts indicated that:

• More than one-quarter of Chapter 11 cases filed prior to 1987 were still pending in mid-1989.
• Approximately half the Chapter 11 cases filed prior to 1987 were closed in Chapter 11 without confirmation of a plan of reorganization, or were closed as no-asset Chapter 7 cases.
• Of the Chapter 11 cases whose plans were eventually confirmed, an average of 740 days elapsed from date of filing until confirmation.
• The report also indicates that only 10% to 12% of Chapter 11 cases result in a successful reorganization of the debtor's business.

As a result of these constraints, the bankruptcy courts are becoming congested by a growing backlog of unresolved cases; and the size and complexity of many simply exacerbate the problem. While these existing cases remain unresolved, they are being added to by an inundation of new bankruptcy filings resulting from a different economic climate and a variety of other reasons.
The Bankruptcy Code requires debtors-in-possession to pay for professionals (including the bankruptcy examiner) who are approved by the court to assist the creditors, shareholders, and other parties in interest. "The administrative costs can be overwhelming--and many companies continue to hemorrhage while in bankruptcy. Meanwhile, the bankrupt entities face mounting hardship as nervous customers transfer business elsewhere, suppliers require more onerous terms, or key employees leave" (Quintero, 1991, p. 42).Therefore, a compelling reason for appointing an examiner is to facilitate the proceedings that can otherwise cause companies to languish and die while in Chapter 11.Examiner who limits their role to preparation of a report is depriving the court, the U.S. Trustee, and the parties in interest of the benefits that his or her knowledge and experience can provide. "Examiners have the opportunity to act as pivotal explosives in breaking the logjam of bankruptcy cases presently burdening the bankruptcy courts" (Quintero, 1991, p. 42).
To this end, examiners can play an invaluable role as advisors to the court and the U.S. Trustees. Further, CPAs are objective and may be better able to undertake detailed reviews of debtors' operations than the court or the U.S. Trustee. An examiner's insights can be useful to the judge or the U.S. Trustee in formulating responses to important issues. Such insights may be imparted informally in conversations with the U.S. Trustee or in the judge's chambers, or even formally by providing expert testimony. Nevertheless, the bankruptcy process is an inherently adversarial process. Typically, the debtor, the different classes of creditors, and shareholders have divergent views on important issues. Each of the parties in interest may present conflicting opinions based on identical data. In smaller cases, the parties in interest may argue about financial or business issues that even the attorneys advocating their viewpoints do not really understand. As a result, the expertise and objectivity of the examiner can be useful in reducing conflict, establishing alignment, and developing an equitable and reasonable basis upon which to proceed.
Examiners can also play an important role in reducing the duplication of services present in many bankruptcies. Today, many companies in bankruptcy are choked by administrative expenses because their activities are reviewed by multiple sets of accountants hired by secured creditors, unsecured creditors, and any other committees that have been formed. An alternative approach is for the examiner to fulfill the review function as an objective single source of professional accounting services.
The examiner can have a pronounced impact on a bankruptcy case by developing a reorganization plan or showing the parties in interest that a company is no longer a viable reorganization candidate and should therefore be dismissed or converted to Chapter 7. However, the examiner cannot recommend that management be replaced by a trustee and then serve as the trustee. "That is a clear conflict of interest and proscribed by the Bankruptcy Code" (Quintero, 1991, p. 42).

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Process in Accounting

The accounting process is a series of activities that begins with a transaction and ends with the closing of the books. Because this process is repeated each reporting period, it is referred to as the accounting cycle and includes these major steps:

1. Identify the transaction or other recognizable event.
2. Prepare the transaction's source document such as a purchase order or invoice.
3. Analyze and classify the transaction. This step involves quantifying the transaction in monetary terms (e.g. dollars and cents), identifying the accounts that are affected and whether those accounts are to be debited or credited.
4. Record the transaction by making entries in the appropriate journal, such as the sales journal, purchase journal, cash receipt or disbursement journal, or the general journal. Such entries are made in chronological order.
5. Post general journal entries to the ledger accounts.
   __________________
   The above steps are performed throughout the accounting period as transactions occur or in periodic batch processes. The following steps are performed at the end of the accounting period:
6. Prepare the trial balance to make sure that debits equal credits. The trial balance is a listing of all of the ledger accounts, with debits in the left column and credits in the right column. At this point no adjusting entries have been made. The actual sum of each column is not meaningful; what is important is that the sums be equal. Note that while out-of-balance columns indicate a recording error, balanced columns do not guarantee that there are no errors. For example, not recording a transaction or recording it in the wrong account would not cause an imbalance.
7. Correct any discrepancies in the trial balance. If the columns are not in balance, look for math errors, posting errors, and recording errors. Posting errors include:
   
   • posting of the wrong amount,
   • omitting a posting,
   • posting in the wrong column, or
   • posting more than once.
8. Prepare adjusting entries to record accrued, deferred, and estimated amounts.
9. Post adjusting entries to the ledger accounts.
10. Prepare the adjusted trial balance. This step is similar to the preparation of the unadjusted trial balance, but this time the adjusting entries are included. Correct any errors that may be found.
11. Prepare the financial statements.
    
    • Income statement: prepared from the revenue, expenses, gains, and losses.
    • Balance sheet: prepared from the assets, liabilities, and equity accounts.
    • Statement of retained earnings: prepared from net income and dividend information.
    • Cash flow statement: derived from the other financial statements using either the direct or indirect method.
12. Prepare closing journal entries that close temporary accounts such as revenues, expenses, gains, and losses. These accounts are closed to a temporary income summary account, from which the balance is transferred to the retained earnings account (capital). Any dividend or withdrawal accounts also are closed to capital.
13. Post closing entries to the ledger accounts.
14. Prepare the after-closing trial balance to make sure that debits equal credits. At this point, only the permanent accounts appear since the temporary ones have been closed. Correct any errors.
15. Prepare reversing journal entries (optional). Reversing journal entries often are used when there has been an accrual or deferral that was recorded as an adjusting entry on the last day of the accounting period. By reversing the adjusting entry, one avoids double counting the amount when the transaction occurs in the next period. A reversing journal entry is recorded on the first day of the new period.

Instead of preparing the financial statements before the closing journal entries, it is possible to prepare them afterwards, using a temporary income summary account to collect the balances of the temporary ledger accounts (revenues, expenses, gains, losses, etc.) when they are closed. The temporary income summary account then would be closed when preparing the financial statements.

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Reversing Entries

When an adjusting entry is made for an expense at the end of the accounting period, it is necessary to keep track of this expense so that the transaction will be allocated properly between the two periods. Reversing entries are a way to handle such transactions.
Consider the case in which a note is issued on the 16th of September, with interest payable on the 15th of October. If the total interest to be paid at the end of the 30 day period is $100, then half of the amount would be allocated to the month of September using the following adjusting journal entry:

Period-End Adjusting Entry

Date	Account Title	Debit	Credit
9/30	Interest Expense	50
	Interest Payable		50
	15 days of accrued interest.

On October 15, the 30 days of interest will be paid as a $100 lump sum. If the bookkeeper remembers that half of that interest already was recorded as an expense in September, then he or she can record only $50 as the interest expense for October. Alternatively, a reversing entry can be made at the beginning of October as follows:

Reversing Entry

Date	Account Title	Debit	Credit
10/1	Interest Payable	50
	Interest Expense		50
	Reversing entry for 15 days of interest accrued in Sep.

Note that the above journal entry is exactly the reverse of the adjusting entry made on September 30. Once this reversing entry is posted, the affected ledger accounts will appear as follows:

Ledger Accounts After Reversing Entry

Interest Payable Oct   1       50 Sep   30      50   Bal.    0

Interest Expense Oct   1       50   Bal.    50

The interest payable account carried a credit balance of $50 over to the new period, and this balance became zero when the October 1 reversing entry was posted. Because the interest expense ledger account was closed at the end of the reporting period on September 30 (as were all expense accounts), its balance was reset to zero at that time. After the posting of the reversing entry on October 1, the interest expense ledger account had a credit balance (i.e. a negative expense balance) of $50.
On Oct 15, the note matures and the $100 interest is due. Because the reversing entry was made on Oct 1, the Oct 15 entry is for the full $100 that is due on the note, and is recorded as follows:

October 15 Journal Entry

Date	Account Title	Debit	Credit
10/15	Interest Expense	100
	Interest Payable		100
	Interest for Sep 16 through Oct 15.

The ledger accounts will appear as follows once the journal entries through October 15 are posted:

Interest Payable Oct   1       50 Sep   30      50 Oct   15      100   Bal.    100

Interest Expense Oct   15     100 Oct   1       50 Bal.    50

The net interest expense for October then is $50, as it should be since the other $50 already was reported in September.
As can be seen in the ledger accounts, the net effect is that a $50 interest expense will be realized in October, and the full $100 of interest will be paid to the holder of the note.
Reversing entries are a useful tool for dealing with certain accruals and deferrals. Their use is optional and depends on the accounting practices of the particular firm and the specific responsibilities of the bookkeeping staff.

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TRIAL BALANCE IN ACCOUNTING

If the journal entries are error-free and were posted properly to the general ledger, the total of all of the debit balances should equal the total of all of the credit balances. If the debits do not equal the credits, then an error has occurred somewhere in the process. The total of the accounts on the debit and credit side is referred to as the trial balance.
To calculate the trial balance, first determine the balance of each general ledger account as shown in the following example:

General Ledger

Cash Sep   1     7500 17 400 25 425 Sep   15     1000 28 500 Bal.    6825

Accounts Receivable Sep   17      700 Sep   25     425 Bal.    275

Parts Inventory Sep   8      2500 Sep   18     275 Bal.    2225

Accounts Payable Sep   28     500 Sep   8      2500   Bal.    2000

Capital Sep   1      7500   Bal.    7500

Revenue Sep   17     1100   Bal.    1100

Expenses Sep   15     1000 Sep   18     275 Bal.    1275

Once the account balances are known, the trial balance can be calculated as shown:

Trial Balance

Account Title	Debits	Credits
Cash	6825
Accounts Receivable	275
Parts Inventory	2225
Accounts Payable		2000
Capital		7500
Revenue		1100
Expenses	1275
	10600	10600

In this example, the debits and credits balance. This result does not guarantee that there are no errors. For example, the trial balance would not catch the following types of errors:

• Transactions that were not recorded in the journal
• Transactions recorded in the wrong accounts
• Transactions for which the debit and credit were transposed
• Neglecting to post a journal entry to the ledger

If the trial balance is not in balance, then an error has been made somewhere in the accounting process. The following is listing of common errors that would result in an unbalanced trial balance; this listing can be used to assist in isolating the cause of the imbalance.

• Summation error for the debits and credits of the trial balance
• Error transferring the ledger account balances to the trial balance columns
  • Error in numeric value
  • Error in transferring a debit or credit to the proper column
  • Omission of an account
• Error in the calculation of a ledger account balance
• Error in posting a journal entry to the ledger
  • Error in numeric value
  • Error in posting a debit or credit to the proper column
• Error in the journal entry
  • Error in a numeric value
  • Omission of part of a compound journal entry

The more often that the trial balance is calculated during the accounting cycle, the easier it is to isolate any errors; more frequent trial balance calculations narrow the time frame in which an error might have occurred, resulting in fewer transactions through which to search.

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